There’s a major tax penalty for forgetting this.
We’re now just a month away from 2023, and while it’s tempting to start planning for the new year already, it’s important to make sure you’ve checked all the boxes on your 2022 to-do list first. The steps you need to take can look different depending on where you’re at in your life.
For young workers, it might mean claiming a 401(k) match and saving for other long-term goals. For those nearing retirement, it could be taking advantage of catch-up contributions. Even when you’re retired, there are still important financial moves you must make to keep your budget on track. Here’s one that no seniors 72 or older ought to skip in 2022.
Remember, you owe the government a cut of your retirement savings
It’s easy to think of our retirement savings as our own hard-earned cash, but if you’re storing it in a tax-deferred account, part of it belongs to the government whenever you withdraw it. That’s because tax-deferred accounts like traditional IRAs and 401(k)s give you a tax break on your contributions in the year you make them.
For most of your life, you get to choose how much you withdraw from your retirement accounts and when. But things change when you turn 72. Then you have to start taking required minimum distributions (RMDs). These are mandatory annual withdrawals that you must make from all retirement accounts, except Roth IRAs. It’s the government’s way of getting its cut of your savings.
If you’re required to make RMDs in 2022, you typically must do so by Dec. 31. However, if you turned 72 in 2022, you have until April 1, 2023, to take your first RMD.
You can take out more than your RMD if you need to, but you can’t go below this amount. Failing to take RMDs results in a 50% early withdrawal penalty on the amount you should have withdrawn — and that’s on top of taxes.
How much money do you have to withdraw in 2022?
The size of your RMD depends on several factors, including your age, your account balance and type, and sometimes your employment status. As discussed, Roth IRAs don’t have RMDs. Roth 401(k)s, which are also funded with after-tax dollars, have RMDs, but you can avoid these pretty easily by rolling your Roth 401(k) funds into a Roth IRA.
You may also be able to avoid taking RMDs from your workplace retirement plan if you’re still employed and own less than 5% of the company you work for. If you fall under this exception, you can delay RMDs from your workplace account until the year you retire. But if you have money in other retirement accounts, like an IRA or a 401(k) from a former employer, you still need to take RMDs from these accounts in 2022.
For your other accounts, calculating your RMD is pretty straightforward. First, you note what the account’s balance was on Dec. 31, 2021. Then, you divide that sum by the distribution period next to your age in the IRS Uniform Lifetime Table. The result is your RMD.
So if you have an IRA with a balance of $100,000, for example, and you’re 75, you’d divide the $100,000 by the 24.6 distribution period for your age and get an RMD of $4,065 from that account. Then, you’d repeat the same process with your other retirement accounts.
Generally, you must take a separate RMD from each account. However, if you have multiple accounts of the same type — for example, two tax-deferred IRAs — you can add the total RMDs up from each account and then take the total from a single IRA if you’d like. Or you can divide it up between the accounts however you like. You could take 25% of your total IRA RMDs from one and 75% from the other, or whatever other method works for you.
If you’re not sure whether you’ve withdrawn enough during the year to avoid RMD penalties, now is a great time to check. There’s still time to take a little more money out before the end of the year, and you don’t have to spend it if you don’t want to. Just move it out of your retirement account so you don’t have to give even more of your savings to the government.